BOJ talks to focus on inflation, rates seen steady

(For more stories on Japan's economy click [ID:nECONJP])

By Leika Kihara

TOKYO, June 13 (Reuters) - The Bank of Japan is expected to keep interest rates on hold at 0.5 percent in a review ending on Friday, though like other central banks it is worried about inflation from soaring energy and raw materials costs.

The BOJ is balancing concerns about rising inflation, running at decade highs in Japan, with a worsening economic outlook -- which has led it to repeatedly warn of downside risks since abandoning a tightening bias in April.

Nevertheless, wholesale prices are rising nearly five times as fast as consumer inflation, squeezing companies that have led Japan's recent growth and prompting investors to wonder if Governor Masaaki Shirakawa will join his counterparts in the United States and Europe in stepping up inflation warnings.

"The risk of stagflation is increasing with inflation accelerating even as the economy weakens," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.

"Shirakawa is faced with a difficult balancing act."

Rising commodity prices have swung the main focus of global policy-makers in recent weeks away from economic growth to the threat of a global spike in inflation.

Federal Reserve Chairman Ben Bernanke signalled this week that the U.S. central bank would act to strongly resist rising inflation, while European Central Bank President Jean-Claude Trichet said rates might rise as soon as July. [ID:nN09303720]

After a two-day meeting, the BOJ's policy board is expected to announce its rate decision between noon and 2 p.m. (0300-0500 GMT). Comments by Shirakawa will be reported after a news conference expected to end by 4:30 p.m. (0730 GMT).

The global threat of inflation is also expected to take centre stage at this weekend's meeting of Group of Eight finance ministers, although measures to tackle it look elusive. [G7/G8]

The hawkish remarks by Fed and ECB officials have heightened market expectations that the BOJ will follow in their footsteps and hike rates later this year, although many economists expect no action at least until early next year.

Derivates are pricing in about a 90 percent chance of a Japanese rate hike by the end of this year, up from less than half earlier this week. MIRS6

While the BOJ sees rising public awareness of inflation as a risk, a rate hike would become an option only if inflation expectations begin to feed on themselves and prices of a wide range of goods shoot up on strong demand, BOJ sources said.

The BOJ had been working towards "normalising" rates in Japan, its parlance for raising the country's very low rates to more normal levels after nearly a decade of deflation.

But the U.S. subprime housing loan crisis has forced the central bank to take a more neutral stance lately.